Ohio

Downtowns lead the way as investment, development expansion continues in Three-C markets.

Commercial real estate investment and development continues to expand in Ohio's Three-C markets, taking advantage of the surge of institutional and REIT cash nationally and strong economic performances in Columbus, Cleveland and Cincinnati.

In somewhat of a turn from the first six years of the 1990s, the downtown markets lead the way as the cities capitalize on new stadiums, arenas and other public and private sector projects.

Columbus shifts focus downtown Take Ohio's capital city, where most of the major office development and investment activity for much of the decade has taken place along the I-270 outerbelt. At least three major office projects started within the last year or so with one or two more in the offing. Underlying this resurgence has been the major expansion of the city's convention center nearly four years ago, the relocation and expansion of the Center of Science and Industry museum and a push for a development master plan of the city's Scioto Riverfront through the downtown. A failed attempt for public financing of the downtown arena and stadium in May was quickly followed by a privately financed arena to host a National Hockey League franchise.

"The real estate market downtown has been driven by a positive economy and other factors to make people look back to the city's core," says the city's economic development coordinator, James Schimmer.

The private sector leader of this downtown renaissance has been developer William Schottenstein, principal with Arshot Investment Corp., which heads two partnerships behind the 220,000 sq. ft. expansion of the Fifth Third Center on Capital Square and the 115,000 sq. ft. Bicentennial Plaza office project along the Scioto Riverfront downtown. An Ohio Equities affiliate is part owner of both projects.

"We feel there are a lot of potential tenants out in the market," Schottenstein says.

Arshot's not the only active office builder downtown. Retail Planning Associates plans to renovate an abandoned 210,000 sq. ft. warehouse on downtown's northern edge into a multitenant facility for itself and other creative professionals. And Columbus-based Pizzuti Development Inc. is expected to get the first phase of an office and condominium complex under way in early 1998 after two years of planning and redesign.

Larry Hoyt, office specialist for Ohio Equities Inc., says many office tenants seek the synergy only a dense downtown market can provide. But he also does not expect any 400,000 to 500,000 sq. ft. office buildings in the near future. "It's essentially pent-up demand," he says of renewed interest downtown.

Third quarter 1997 figures from CB Commercial Real Estate Group show the new development projects have started to push up vacancy rates, loosening up what has been a three-year tight market downtown. Vacancies hit 9.4% in Class-A with average rates of $17.46 per sq. ft. Class-B office have held steady or edged down a bit, with a 6.8% vacancy during the third quarter at average rates of $14.67 per sq. ft.

Bill Baumgardner, a Pizzuti Realty Inc. senior associate, dismisses the Class-A move as the result of the "dynamics in the marketplace changing." He says the fall announcement that Star Bank would return its regional headquarters downtown after a 10-year absence denotes the start of a new trend. It and other more recent transactions sopped up some of the excess. "There's a little bit of momentum building in terms of leasing activity coming back downtown."

Even so, Baumgardner says the true test of the downtown market's viability will be the results of the sale of three downtown properties now on the market, a view shared by Benton Benalcazar, an Adena Realty Advisors principal. In the suburbs, Benalcazar notes Equitable Real Estate Corp. paid $15.5 million, or $129 per sq. ft., for a Dublin office building The Alter Group developed a few years ago, while Los Angeles-based American Realty Advisers paid $18.5 million, or about $110 per sq. ft., for an older building five miles away.

"That demonstrates the strong institutional demand for suburban office," Benalcazar says. "It's an absolute fight to buy office buildings in the suburbs. Because of this strong competition, you're starting to see investors looking at the central business district."

Like downtown, the suburbs have had some increases in vacancy, a rise attributed to a few situations where tenants have left office space due to relocation or downsizing and the continued surge of new product. Dublin still commands the suburban office development roost.

Duke Realty continues to expand in the Tuttle Crossing office park, with the first half of its 290,000 sq. ft. spec Atrium II office due for completion in spring 1998. And Pizzuti Development has picked up the pace in the MetroCenter commercial development, completing a 90,000 sq. ft. spec building.

This development activity has contributed to a rise in suburban vacancies. CB Commercial research shows Class-A at 10% with average rates at $13.76 per sq. ft. Class-B is more stable, with vacancies at 4.5% and rates averaging $14.15 full-service. Benalcazar says suburban Class-A rates are about $1.50 per sq. ft. higher than a year ago. It's also difficult for corporate tenants to find 40,000 to 125,000 sq. ft. of contiguous spec space in the suburbs, he says.

In the meantime, the number of competing office parks in the suburbs continues to expand. The highest visibility in the corporate market are Easton and New Albany, Benalcazar says.

New York developer Georgetown Co. and Limited Inc. Chairman Les Wexner have opened up nearly 200 acres of farmland to development on the northern edge of New Albany as an alternative to the 1,200-acre Easton development the Limited/Georgetown partnership has started along the outerbelt.

Within Columbus' industrial market, vacancy rates have edged up as suburban tax incentives push the development of new bulk warehouse space. At the same time, tenants have shown some reluctance to commit to new space.

Figures from Mathews Click Associates show mid-1997 vacancies at 6.4%, about half a percent higher than in mid-1996. The vacancy is highest with 1.8 million sq. ft.-plus, or 15%, in the southwest Columbus quadrant where Pizzuti, Duke Realty, Security Capital Corp. and Columbus developer Ruscilli Real Estate Services all have development tax-abated projects awaiting users.

Mike Hurd, Mathews Click senior marketing manager for industrial, blames much of the vacancy on tenants who delayed decisions on leases. Heading into the fourth quarter 1997 and first quarter 1998, he says he expects more commitments as tenants stop kicking tires and request quick turnaround on final improvements.

At the same time, he says rates have remained steady, from $2.85 to $3.25 per sq. ft. triple net on tax-abated properties.

The largest lease to date has been the 170,000 sq. ft. deal by Laura Ashley Inc. within a Pizzuti facility at Rickenbacker Air Industrial Park, a foreign trade zone park at a former Air Force base.

Duke has yet to build a new project at Rickenbacker, but it did buy its way into the market in June with the purchase and partial leaseback of the 785,000 sq. ft. Sun Television and Appliance office/distribution center.

Opus North Corp. has the first of two 434,000 sq. ft. spec industrial projects. Opus' J. Kurt Dehner says the $12 million project offers the most modern space under one roof in Columbus.

The availability of space has not hurt the investment market, as evidenced by the midsummer purchase of 770,000 sq. ft. of older industrial property by Prime Group of Chicago for $15.6 million.

"Columbus is on the institutional radar as a good market," says CB Commercial's William D. Morrisey. "There are more buyers than product available."

Cincinnati has public participation Cincinnati also has had more than its share of downtown development projects, almost all of it with significant public financial participation.

The city has a new NFL stadium for its Bengals franchise close to construction, while plans for a baseball-only facility slowed somewhat during 1997.

The city also has acquired and leased land to a consortium of developers finishing the first phase of Fountain Place, a retail and office project on the city's central Fountain Square. The three-story, 215,000 sq. ft. first phase opened in October with plans for Fifth Third Bancorp to build an 18-story office building on top when it needs expansion space.

"It's central to the redevelopment downtown," says Arn Bortz, partner with Towne Properties, co-developer of the project with Duke Realty, Belvedere Corp. and Madison Realty Partners in a consortium called the Cincinnati Development Group.

The retail project consists of a three-story, 180,000 sq. ft. Lazarus Department Store as well as a 7,500 sq. ft. Tiffany's and a similar-sized Brooks Brothers. Perhaps more important, Bortz says, Fountain Place bolsters other nearby retail.

"It wasn't until this project came on line that people began to feel good about the direction of downtown," says David Smith, manager of economic development for Cinergy Corp.

Bortz says some in the downtown real estate market have begun casual talk about new office development, even with Class-A vacancies hovering at 10% and Class-B even higher. CB Commercial's research shows suburban office rates just a bit lower.

Factors behind the talk of development include the lack of contiguous space both downtown and in the suburbs. Provident Financial Group also took nearly 270,000 sq. ft. of space off the market earlier this year.

Still, the Fifth Third building will not move forward until the company signals it needs at least some of the space for growing operations, which it traditionally has kept downtown, Smith says.

Tom Devitt, president of Devitt & Associates, is more enamored with the pace of development outside of downtown, along the I-71 and I-75 highways into the suburbs and the outerbelt, I-275.

"There are a lot of people out in the suburbs doing well," he says. "Life is good along the interstates." Build-to-suit and spec office projects continue their advance north of downtown, a trend Devitt expects to last through 1999.

Duke has become the leading player with about three-quarters of the spec office business. It has acquired two office buildings with a combined 200,000 sq. ft. during the first half of 1997.

Perhaps the strongest commercial real estate segment in Cincinnati right now is industrial.

Khoury attributes the surge to expansion of local and regional companies as well as consolidations. Tax abatements on both sides of the river also have encouraged development, and the airport has attracted a lot of the newer projects into northern Kentucky, he says.

A late-September Ostendorf-Morris report shows the overall industrial market will add about 5 million to 6 million sq. ft. in new product.

Khoury says there remains some threat of overbuilding. Still, he says very low vacancy in the northern Cincinnati submarket has prompted Duke and Security Capital to break ground on 775,000 sq. ft. of bulk distribution space.

Khoury also notes some activity in industrial sales, with $40 million worth of properties changing hands during the first half of 1997. The limited supply of product and escalating prices did slow activity during the second quarter.

Cleveland replaces older facilities Cleveland's downtown has benefited from an ongoing replacement of older sports facilities. With the Indians and the Cavaliers settled, the city is now concentrating on completing a new NFL stadium when football returns in 1999.

"It creates another lure downtown," says Jim Kroeger, Cleveland Growth Association business development director, of the attraction of more people to the lakefront. Developments such as a science museum, the Rock 'n' Roll Hall of Fame and the revitalization of an old industrial area along the Cuyahoga River into the Flats entertainment and restaurant center have spurred other hotel and retail opportunities downtown and supported the regional economy.

The region as a whole also has benefited from East Coast firms seeking lower-cost sites for back-room operations. In addition, Kroeger says Cleveland has had solid growth in its "bread and butter" economic sector: manufacturing.

Downtown, office vacancy rates have improved immensely since Class-A properties hit 31% in 1991, says Doug Leary of CB Commercial Real Estate. According to a third-quarter CB Commercial survey, vacancies in the Class-A market downtown now stand at about 8.7%, with average rates at $21.45 per sq. ft.

Leary does not expect the lower Class-A rates to stir development fever any time soon, largely due to the high Class-B vacancy of more than 23% downtown, with rates at $11.57 per sq. ft.

"It will be at least two years before anyone talks about construction," Leary says, and another five years or more before something is completed.

Not all Class-B properties have suffered, according to Don Craven of First Union Real Estate Investment Trust. In fact, First Union's 55 Public Square has less than 5% vacancy as the REIT continues its renovation programs.

The suburban office market has solid rates, occupancies and development prospects, Leary says. Class-A vacancies represent just 5.9% of the 5.7 million sq. ft. in the CB Commercial survey. It also had lease rates at just over $18 a sq. ft.

Leary says the hottest Class-A development remains in the south suburban market near Independence along Rockside Road and the east suburban markets. At the center of this market is the Landerbrook/Landerhaven corporate office development, where both build-to-suit and spec office development has occurred in recent years.

Cash-rich Duke has quickly expanded in this office environment, bolstering its portfolio in late 1996 with the $21 million addition of more than 200,000 sq. ft. of office space in three buildings known as Corporate Circle and Corporate Place. Rockside Road also has attracted Duke interest, with 70,000 sq. ft. spec office under way and another 140,000 sq. ft. nearing construction at its Freedom Square Three.Other developers, such as Cle veland-based Dallad Group, also have been active in that market.

The Cleveland industrial market continues to become stronger. Grubb & Ellis research showed industrial vacancy dropping to 12.7% during the second quarter, a one point drop from the 1996 period. But Alec Pacella, Grubb & Ellis client services manager, says the number is deceptive because many of the vacant buildings are manufacturing facilities left from the 1950s and '60s.

"Cleveland has typically been a steady market," he adds. "You're not going to see huge numbers; the market's not like that. But you also won't have buildings that in a fast-growth market will sit idle for three years."

Brian Ball covers real estate for Business First in Columbus, Ohio.

After several years of sopping up hotel supply built in the late 1980s, Columbus has become a hotbed of activity for new product, including the first full-service hotel development of the 1990s and a slew of new rooms downtown.

Occupancy has started to slide in downtown Columbus. Smith Travel Research shows demand up 5.9% during the first half of 1997, but the higher increase of 9.9% growth in room nights forced occupancy down to 67.5% from 70% during the first half of 1996. For the year, Eric Belfrage, principal with Lorms & Belfrage Inc., expects room nights to expand 13% in 1997, 12% in 1998 and another 5% into early 1999. That growth should force occupancy down to the low 60s in the coming years, he says.

In Cleveland, Smith Travel Research shows marketwide occupancy at 67.7%, below the 70.7% and 69.3% set in 1995 and 1994, respectively. But rates have risen from $60.92 to $71.84 during the same period. That has encouraged developers such as Jacobs Group, which has projects under way in suburban Middleburg Heights, Independence, North Olmstead and Westlake.

Like Cleveland and Columbus, Cincinnati has experienced improvements in rates in the last few years. However, its occupancies have not experienced the trend of the other two cities. John Todia, executive vice president of Winegardner & Hammons Inc., says suburban properties have performed in the mid- to high-60s in occupancies, but downtown has hovered around 60% for some time.

Smith Travel Research shows Cincinnati rates have grown despite stagnant occupancies, which have varied from 62.2% to 62.8% in recent years. Average rates hit $67.24 in 1996 vs. $61.03 in 1994. Belfrage attributes the steady occupancy to supply growth keeping up with the 3.5% increase in 1996 room-nights sold.

REITs and institutional investors have shown high interest in older multifamily portfolios amid high occupancies and strong rental rates in all three Ohio markets. But Cincinnati and Cleveland at this point seem to have few takers.

A first quarter survey by the Danter Co., a Columbus-based real estate consulting firm, showed average vacancies at 3.8% in Columbus across all apartment sizes and submarkets and 105,100 units checked, down from 4.4% in the previous quarter. Cleveland vacancy edged up 70 basis points to 3.7% in the most recent survey among 72,000 market-rate apartments, a fluctuation attributed in large part due to seasonal factors. The 39,400 Cincinnati apartments surveyed, which did not include the east submarket and the University of Cincinnati submarket, came in at a strong 3.2%; Northern Kentucky led the Cincinnati submarkets at 3.8%.

"All three markets are good and sound, with low vacancies and 2.5% to 3% rent increases," says Danter Co. President Kenneth Danter.

The low vacancies have become attractive to REITs and other investors because it allows for rent growth. But metro Columbus has 25,000 units in the development pipeline over the next three to five years, a number that should be shaved down somewhat through zoning restrictions. "If too much does get built in the next two years or so, it's very possible we get into a soft market," Danter says.

In contrast, Danter expects just a fraction of that growth pace in Cincinnati and Cleveland, suggesting a better investment market. Still, investors have strong interest in Columbus and its Ohio sister cities. Older properties, in fact, have received the most attention in the last year.

The Cincinnati investment market has not been that brisk, in large part because local developers and investors tend to hang onto their properties, says RE/Max Greater Cincinnati Commercial Group investment specialist Jeff Dilbone. Overall investment activity this year should hit $80 million to $100 million. And development adds just 1,500 to 2,000 apartments a year, adding to the tight market.

Cleveland mirrors Cincinnati. The northeast Ohio market also has experienced more activity in the sub-Class-A investment market, but Vicki Maeder of CB Commercial says the actual number of sales is not high. "I am getting a lot more calls for Class-B and even Class-C properties to get rehabbed," Maeder says, adding that local investors rarely will sell the properties, instead opting to refinance.

Columbus has a lot more apartments in all classes available, according to Adena Realty Advisors' Principal Richard Schuen. That has translated into solid investment opportunities for investment groups.

Schuen and Danter attribute the strength of the Columbus market to the underlying economic growth it is experiencing, with solid job growth and the need for places to house new workers. Construction costs, meanwhile, have soared because of the tight labor market.

"There's a real high interest in the older properties because you can buy them for $18,000 to $20,000 per unit vs. $45,000 to $50,000 for newer Class-A properties," says Schuen. Investors can achieve strong rents even after putting in a few thousand dollars per unit in rehab.

Columbus property owners also sense now is the time to cash out, he says. "There's a lot of money chasing deals, giving these original owners an opportunity for an exit strategy."